Velocity of Money

Think of money as something that can be used repeatedly during a period. The statistic does not follow its individual journeys, however. The economic database FRED calculates US M2 velocity as quarterly nominal gross domestic product, expressed at an annual rate, divided by the average M2 stock over that period. GDP measures production value, while M2 is a defined grouping of money, including cash and eligible deposits. We therefore divide a flow over time by a stock of money. “How often money turns over” is a useful intuition, but the measure does not add up every payment or financial-asset trade. It cannot tell you how often someone spent your particular banknote. [1]

Time units are an easy place to go wrong. FRED’s GDP series expresses quarterly output at a seasonally adjusted annual rate: regular seasonal fluctuations are adjusted and the result is stated as if that pace lasted a year. In our simplified model, quarterly flow is 300, its annualised equivalent 1200, and the average money stock 600. Annually, 1200/600 = 2; for the quarter alone, 300/600 = 0.5. The value 2 therefore does not mean two turnovers during one quarter. Annualisation neither observes a future year nor predicts that subsequent quarters will be identical. [2]

The quantity of money changes within a period. Our monthly stocks of 400, 600 and 800 give a simple quarterly average of 600. Dividing annualised nominal flow of 1200 by that average gives velocity of 2. Using only the final 800 would give 1.5. That would be a differently constructed measure, not a correction of the original calculation. FRED explicitly specifies an average for M2V. It is equally important not to mix currencies, millions with billions, or adjusted and unadjusted data. Align the inputs before comparing results. [1]

M1 and M2 are monetary aggregates: statistical totals covering different ranges of money. FRED therefore publishes M1V and M2V separately. In our model, the same nominal output of 1200 with average M1 = 400 gives velocity of 3, whereas M2 = 600 gives 2. The higher first value does not mean people produced or bought more: the numerator stayed unchanged while the denominator changed. A revised statistical definition or a shift between components can also move the ratio. Two charts labelled velocity need not measure the same thing. [3]

The US statistical agency BEA measures GDP as the value of final goods and services. Intermediate inputs used in production are not added again, which would count the same production repeatedly. In our small example, 100 items priced at 10 have a value of 1000. At a price of 11, that becomes 1100. With the same money stock of 500, velocity rises from 2 to 2.2, although real quantity remains 100 items. The monetary total changed because of price. Higher calculated velocity alone therefore does not prove that the economy produces more or that money transfers happen technically faster. [4]

For interested readers, the definition is V = PY/M, or M × V = P × Y. V is velocity, M money quantity, P the price level and Y real output; P times Y is output’s monetary value. Quantity Theory of Money builds on this relationship in considering money and prices. If we double M while production value stays unchanged, calculated V halves. That alone establishes neither the cause nor future inflation. FRED Blog illustrates changing willingness to hold money and its relationship with interest rates. Constant velocity is an assumption to check, not a guarantee provided by the equation. [5]

BTC is bitcoin’s currency symbol. A transaction input refers to a previously received amount that is now being spent in full. Outputs specify new amounts and the conditions for spending them later. The blockchain records coin movements, not automatically newly produced goods and services. Bitcoin Developer Guide describes a change output: a transaction portion returned to the payer, rather like change from a larger banknote. In our model an input of 1 BTC becomes a payment of 0.2 BTC, change of 0.799 BTC and a fee of 0.001 BTC. The fee is not a separate output of this transaction. Total outputs of 0.999 BTC are not the purchase price of 0.2 BTC. Nor does the chain alone prove the payment’s purpose. Transfers between your own addresses or purchases of existing assets are not automatically new final production. Adding on-chain amounts therefore does not yield a comparable economic velocity. [6]

A fall in Velocity of Money can reflect lower nominal output, a larger money stock or both. Monetary Deflation, a decrease in money under a chosen definition, describes a different quantity; with the flow unchanged, less money would actually raise calculated velocity. V alone cannot distinguish every cause of a change. Examine the original series, periods and any revisions. Then ask why people want to hold readily available money and how credit conditions are changing. Keep methods consistent across countries and years. This ratio alone cannot provide a reliable BTC price forecast. [5]